Wall Street Journal - February 15, 2000
Heard on the Street
Margin Debt Set a Record In January, Sparking Fears
By GREG IP Staff Reporter of THE WALL STREET JOURNAL
The amount of debt that investors took on to buy stocks in January shot up to another record even as the value of stocks fell, raising fresh concerns about speculative activity on Wall Street.
It is a staggering statistic: Such debt -- known as margin buying -- rose 7% among New York Stock Exchange-member brokerage firms, to $243.5 billion in January. Margin levels are now up 36% since September.
The worry? This debt load could magnify any fall in the stock market, as selling from investors who are forced to meet margin calls exacerbates a decline.
A somewhat comforting thought -- at least on a relative basis -- is that much of this piling on of debt isn't being done by the proverbial guy on the street. In fact, what is driving it appears to be not an increase in leverage by the average investor, but an increase in activity by investors who already like to use leverage.
Anecdotal accounts suggest the extra debt has been taken on primarily by a small portion of investors who trade fast-moving technology stocks, whose value has skyrocketed in the past 12 months, and by hedge funds, big investment pools for wealthy individuals who often use leverage to maximize returns.
At Dallas-based Southwest Securities Group Inc., for example, which clears for many day-trading firms, whose customers trade in and out of the same stocks all day from sophisticated workstations, saw margin debt rise about 35% in the final six months of 1999 to $900 million, said Eddie Anderson, executive vice president of operations.
But equity in the accounts, he says, remained steady at 49%. That means about half of the stocks of the average Southwest customer with a margin account was backed with borrowed money, significantly above the national average. Mr. Anderson said the rise in margin debt was due not to customers becoming more leveraged, but to "the volume and the investment activity in the market in general."
So why the jitters? Margin lending has historically moved in tandem with the market's value. The recent burst of margin borrowing in the market has been more alarming because it has outrun the rise in stocks' value, which actually fell 4% in January and is up just 13% since September. That indicates a rise in leverage.
Margin debt now equals 1.57% of market value, equal to its peak in the fall of 1987 ahead of the October 1987 stock-market crash, according to Bianco Research, although different market value measures suggest the ratio was somewhat higher in the early 1980s. By comparison, that ratio approached 30% in 1929.
Under the Federal Reserve's Regulation T, an investor may make up to 50% of an initial stock purchase with borrowed money. Thereafter, he or she may let the portion of debt rise no higher than 75% of the value of the stocks in the account.
"There's no fear among individual investors," said Charles Biderman, chief executive of TrimTabs.com (www.TrimTabs.com), which tracks flows of money in and out of the securities markets. "They can't imagine that stocks can go down or they wouldn't be borrowing this heavily."
"That's how you get those panic plunges," said Fred Hickey, editor of High Tech Strategist newsletter. "When we bottomed in October 1998, it was on a panic selling [triggered by] margin calls."
Many economists play down the rise in margin debt, noting it remains tiny relative to stock values and even other types of debt, which are also rising briskly. Consumer credit stood at $1.4 trillion and mortgage debt at $4.5 trillion in December, both up 10% from a year earlier, according to the Fed.
At Charles Schwab Corp., the country's largest discount broker, margin debt has risen only slightly to 2.3% of customer assets at the end of December from 2.2% at the end of June (although 39% of those assets are mutual funds).
Regulators have watched the spike upward in margin debt with concern. Securities and Exchange Commission Chairman Arthur Levitt, in a speech Saturday, said, "In too many cases, investors are focusing on the upside -- without carefully considering the downside." The SEC recently launched a study of the issue and is consulting with the Federal Reserve, the Treasury Department and the Commodity Futures Trading Commission.
People familiar with those discussions said nothing has been decided, but the latest data will likely accelerate deliberations. Most of the regulators are skeptical about additional government action, and Fed Chairman Alan Greenspan, although acknowledging concern, has specifically ruled out curbing the level of borrowing allowed for buying stocks. The most likely action from Washington, if any, would be more jawboning by officials, as well as prodding the exchanges and firms to further limit borrowing activity in the most volatile stocks. In December, the NYSE and National Association of Securities Dealers proposed stricter margin requirements for day traders only. The proposal awaits SEC approval.
Still, the focus on individual borrowing may overlook rising leverage among professionals such as hedge funds. Not since 1929 has a market collapse been attributed to overleveraged individuals, historic accounts suggest. By contrast, 1998's stock plunge was fueled by the near collapse of Long-Term Capital Management and other hedge funds and the October 1987 crash was aggravated by professionals trading stock-index futures. Just two weeks ago, the bond market went wonky as the Treasury's bond buyback plan whipsawed leveraged dealers and hedge funds.
Although margin debt rose 25% from the third to the fourth quarters of 1999 at Schwab, it rose an even sharper 33% at Bear Stearns Cos. As the country's largest trade-clearing broker, Bear Stearns handles margin lending for many smaller brokerage firms. It also lends to hedge funds; indeed, slightly more than half of its clearing business is for institutions such as hedge funds.
Richard Lindsey, co-president of the firm's clearing unit, said the rise in margin debt reflects rising value of the stocks in the accounts, not increased leverage. Furthermore, "We, like many firms, over the past year or so have raised margin requirements on some of the highfliers." Schwab initiated a list of 22 volatile stocks requiring stricter margin requirements in November 1998, and it has since grown to more than 200, a spokesman said.
Still, Bear Stearns's Mr. Lindsey said the firm saw more borrowing by individual investors than hedge funds in the latest quarter. Furthermore, many hedge funds borrow through "joint back offices" with brokerage firms like Bear Stearns, thereby obtaining higher leverage that doesn't appear in margin data.
Some of the rise in household margin borrowing, rather than financing stock speculation, might be financing consumer purchases through checks and debit cards drawn on brokerage accounts. Mr. Biderman says a divorced acquaintance used his margin account in December to make a payment to his ex-wife. Unfortunately, his position in Internet stock CMGI Inc. went against him, forcing him to sell some in January.
Christine Callies, market strategist for Credit Suisse First Boston, worries the economy could take a blow if leveraged investors are forced to liquidate rapidly. "The particular type of people that have leveraged up recently seem to be very excitable. We can guess these guys aren't leveraging up to buy AT&T. As interest rates go up, they have to shoot for higher returns to pay the service on the debt."
Jim Willsie, a retired engineer in Clearwater, Fla., can attest to that. If a stock he owns falls, he'll often double his holdings for the day with borrowed money, on the theory the stock need only retrace half its drop to break even. But if it doesn't come back, and "You're losing somebody else's money, it hurts twice as much. That's when the panic sets in." Last summer he lost about $5,000 when he bailed out of Internet highflier Ask Jeeves Inc., only to watch it bounce right back.
-- Jacob M. Schlesinger contributed to this article.